Initiative 601: Experience and Context

1. Initiative 601: Experience and Context Presentation to the House Finance Committee by the Office of Financial Management Victor Moore, Director Irv Lefberg, Chief of Forecasting February 1, 2005

2. Major Provisions of I-601 • Establishes annual limits on General Fund state expenditure growth based on three-year averages of inflation and population growth, called “fiscal growth factors.” • Under original I-601, the expenditure limit was reduced when program costs or revenues were shifted from the General Fund to other state accounts; but the limit could not be raised when such program costs or revenues were shifted back to the general fund. • A new provision adopted in 2000 in HB 3169 allows adjustments in both directions. It establishes that the state expenditure limit can be adjusted upward when program costs or revenues are transferred to the General Fund from another state fund or account. • Requires a 2/3 majority of both houses of the Legislature to increase revenues. Office of Financial Management

3. Budget Drivers = Specific Population Growth Specific Inflation Change in Utilization + + + Policy Change EXAMPLE: MEDICAL ASSISTANCE Ages 18 – 39 Females and other age groups Medical Services Inflation Factors Affecting Enrollment (e.g., Economy) Changing Eligibility Criteria I-601 Spending Limit = Adjustments due to Fund Shifts General Population Growth + General Inflation + Components of Expenditure Growth Office of Financial Management

4. Average Projected Growth 2005 – 2009 (assumes average economic growth) The I-601 Calculation • Inflation 2.5 % 3.8 % • Population Growth 1.3 % • Real Per Capita Personal Income Growth (Productivity) 2.0 % 5.8 % PERSONAL INCOME GROWTH = 1.2 Point Difference To forecast revenue, economists multiply personal income growth by a factor of between 0.85 and 0.95, since revenue grows more slowly than personal income. 5.0 % REVENUE GROWTH = 5.8% x 0.87 = Structural Difference Between Revenue Growth and I-601 Office of Financial Management

5. 13.6% I-601 takes effect 10.8% 10.0% 9.3% 9.1% 8.0% 7.6% 6.5% 6.5% 5.9% 5.7% 5.3% 4.0% 3.6% 2.8% 2.4% 2.0% 1.9% 1.2% 0.5% 0.3% 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Fiscal Year Strong economy, increased spending on health care and education Smaller growth in government spending due to economic slowdown Economy recovers, Initiative 601 takes effect, slowdown in spending, tax reductions Growth in State General Fund Expenditures Office of Financial Management

6. I-601 takes effect 6.7% 7% 6% 5.7% 5.4% 5% 4% 3% 2% 1% 0% 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 State spending as a percentage of total state personal income has declined since Initiative 601 took effect. Office of Financial Management

7. $23,000 $22,000 Revenue without tax changes $21,000 $20,000 $ millions Initiative 601 Spending Limit $19,000 $18,000 Revenue with tax changes $17,000 $16,000 1993-95 1995-97 1997-99 1999-01 Tax reductions passed between 1994 and 2001 had the effect of reducing annual General Fund revenues to approximately the Initiative 601 spending limit. Office of Financial Management

8. Expressed in terms of 1999-2001 Biennium Impact Transferred to Other Accounts Tax Reductions $1.8 Billion (62.2%) $495 Million (17.1%) Emergency Reserve Account $598 Million (20.7%) $2.9 billion of unspent General Fund revenues was returned in the form of tax cuts, transferred to other accounts, or deposited in the rainy day fund. Office of Financial Management

9. Six factors that helped spending growth stay within I-601 constraints (through 99-01 Biennium) • Welfare reform, which substantially reduced caseload growth in the state’s public assistance programs. • Temporary reduction in medical services inflation and other cost savings in health care due to the introduction of managed care practices. • Slowdown in salary growth for state employees. • Additional, unexpected one-time revenues (e.g., the “tobacco settlement”) which helped fund health care programs outside the general fund. • Favorable investment climate which (at least temporarily) reduced public contributions to state pension funds. • Flat growth in K-12 enrollment. Office of Financial Management

10. Budget Share Juvenile Rehabilitation 0.7% Ages 12 - 17 Corrections 4.9% Males Ages 18 - 39 Medical Assistance 10.6% General Population Long-Term Care 4.6% Ages 85+ TANF 3.7% Children Ages 0 - 17 Higher Education 12.0% Ages 17 - 29 K-12 Education 43.1% Ages 5 - 17 Projected Change in Budget Driver Populations2003 - 2007 Total Population Growth: 5.8% Source: OFM November 2004 State Population Forecast Office of Financial Management

11. Annual Change in School-Age Population (Population Age 5 – 17 Years) forecast However, K-12 enrollments are forecast to surge again after 2008. Office of Financial Management

12. Actual Change U.S. CPI IPD Percent Change in Employer Medical CostsPer Employee* Percent 2004 Predicted 13.0% 1987 1990 1995 2000 2004 *Companies with 10 or more employees Sources: Mercer National Survey of Employer-Sponsored Health Plans 2003, Global Insight, Office of Financial Management Office of Financial Management

13. Juvenile Rehabilitation Long-Term Care Prison Higher Education TANF 6.8 0.8 5.3 12.3 4.6 High High Low Low Low --------- --------- --------- --------- High --------- --------- --------- --------- High Percent of Budget Demographic Pressures Inflation Pressures Policy Pressures High (class size, COLAs) K-12 Education 43.5 Low* --------- High (aging of the population) Medical Assistance 9.5 Very High High *Demographic pressures for K-12 will begin to accelerate in FY 09. In addition to health care “inflationary” pressures, policy pressures across several major programs are high. Office of Financial Management

14. (Builds on 2003-05 Supplemental Budget as passed in April 2004) Scenario 1 Scenario 2 X X Employee COLAs IPD Caseload growth – based on official caseload forecasts where available OR X X Growth in associated population group X X Higher education maintains its 03-05 General inflation (goods and services): IPD – 2.2 % participation rate. X X X X No other policy adds are included. IPD 2.2% 10% Annual growth in per capita health care costs: Growth in pension contributions: IPD 2.2% State Actuary’s Estimate* *not including gain-sharing Fiscal Outlook2004 – 2009 Office of Financial Management

15. PROJECTION 2005 2006 2007 2008 2009 2004 $11,882 $12,077 $12,698 $13,190 $13,824 Total Revenues & Resources $11,531 $11,994 $12,400 $12,759 $13,118 $13,369 Total Expenditures $11,452 ($113) ($323) ($60) $72 $455 DIFFERENCE $79 ($257) ($397) ($440) ($121) TOTAL RESERVES/DEFICIT* Result: Revenue almost keeps pace with budget pressures. Scenario 1: All programs, including health care costs and pension contributions, grow based on caseload/specific population growth and general inflation. Revenue grows 5% annually. Office of Financial Management

16. PROJECTION 2005 2006 2007 2008 2009 2004 $11,882 $12,077 $12,698 $13,190 $18,824 Total Revenues & Resources $11,531 $11,994 $12,834 $13,462 $14,293 $14,899 Total Expenditures $11,452 ($113) ($757) ($764) ($1,102) ($1,076) DIFFERENCE $79 ($690) ($1,534) ($2,751) ($3,962) TOTAL RESERVES/DEFICIT* Result: Revenue does not keep pace with budget pressures. Deficit is difficult to manage. Scenario 2: Same as Scenario 1 except health care annual cost per case growth is 10 percent and pension contributions are based on State Actuary’s estimates. Office of Financial Management

17. Projected Annual Growth Personal Income 5.8% Six-Year Outlook – Spending 5.5% (including current trend in health care inflation, COLAs, class size reductions, and pensions) Revenues 5.0% Inflation + Population Growth 3.8% (I-601 factors) Office of Financial Management